Bernstein and Ricardo Report: Cheap Will Beat Cool in Vehicle Electrification
On September 26, 2011, Bernstein Research and Ricardo plc published a 450 page analytical report titled, "Global Autos: Don't Believe the Hype – Analyzing the Costs & Potential of Fuel-Efficient Technology," which combines best in class securities research from Bernstein with the deep automotive expertise of Ricardo, a global leader in engineering, product innovation and strategic consulting. The result is the most comprehensive, detailed and eminently reasonable forecast of short-, medium- and long-term trends in advanced automotive powertrain technology that I've had the pleasure to read.
It's devoid of axe grinding or cheer-leading and simply describes how the auto industry is likely to evolve over the next couple decades. The key takeaway is two themes I regularly stress – Cheap Beats Cool and Baby Steps Rule.
Since the "Black Book" is far too detailed and comprehensive to adequately explore in a blog like mine, I think the best approach will be to summarize the key conclusions and explain how the expected evolution of powertrain technology will impact the companies I write about.
Overview. Bernstein and Ricardo are bullish on gasoline and advanced diesel technology, but cautious on the near term or medium term prospects for electric vehicles. They believe advanced automotive technologies must be affordable before logical consumers will buy new-generation vehicles in significant quantities. They have concluded that improvements to conventional engines will be key over the next 10 to 15 years and HEVs will become viable on a large scale by 2020. They believe near-term mass market adoption of electric vehicles is unlikely given the tough financial comparison with ever improving combustion engine vehicles. While premium-priced plug-ins may become viable earlier, by definition they will be niche products.
Conventional engines can meet 2020 regulatory targets at low cost. While widespread adoption of several emerging technologies including downsized engines, turbocharging, advanced fuel injection, stop-start idle elimination, advanced transmissions and other technologies that reduce rolling losses will be needed to meet regulatory targets, a shift to more expensive hybrid and electric drive technologies is unnecessary and unlikely. Except for Nissan-Renault, automakers' electric drive ambitions point to high-profile concept cars coupled with vaguely modest production plans.
Current HEVs and Plug-in Vehicles have much higher TCOs than conventional powertrains. Bernstein and Ricardo estimate the total cost of ownership, or TCO, of a conventional C-segment car at €21,300 ($28,400) over a typical four-year ownership period for the first purchaser. Without exception electric powertrains fail to offer any cost savings with HEVs costing approximately €1,650 ($2,200) more over four years, PHEVs costing approximately €4,500 ($6,000) more over four years and EVs costing approximately €10,800 ($14,400) more over four years.
Aggressive downsizing and modest electrification will be needed after 2020. To move from niche to volume production, PHEVs and EVs require a breakthrough in battery performance (energy and power density) and cost to overcome range anxiety and TCO concerns. While aggressive downsizing and modest electrification will be required from 2020 on, Bernstein and Ricardo believe the auto industry can meet regulatory targets with a 10% market share for HEVs, a 4.5% market share for PHEVs with small battery packs and a 4% market share for full BEVs. They estimate that the current cost differential between manufacturing a conventional car and manufacturing the same car with an electric powertrain is on the order of €16,000 ($21,500) before incentives.
At current vehicle costs and tax rates, oil would need to cost $300/bbl in Europe, $500/bbl in China and $800/bbl in the US before plug-ins would break even with conventional vehicles. Bernstein and Ricardo believe market forces alone are unlikely to provide enough incentive for a demand pull in electrified powertrains. While electric vehicles are likely to benefit from sizable cost reduction opportunities, combustion engines will require more expensive technology upgrades. The combination of the two will lower the break-even point for fossil fuels by ±20% over the next five years and another 35-40% by 2020. By 2025, Ricardo and Bernstein expect EVs to be competitive with conventional vehicles.
Battery cost reductions will be a key driver of future vehicle electrification. Bernstein and Ricardo estimate that currrent battery pack costs range from €4,500 ($6,000) for PHEVs to €13,500 ($18,000) for full electric vehicles, or $750-$800 per kWh of pack capacity. Battery costs will need to halve if EVs are to break even with internal combustion. Historical trends indicate that battery costs will decline by roughly 5% per year, which should bring costs down into the $310-$350 per kWh range by 2025. Until then, governments will need to bridge the gap with subsidies of several thousand dollars per vehicle for electric powertrains to be competitive.
Hybrids, PHEVs and EVs require significant amounts of additional raw materials. Conventional cars are material intensive but batteries and traction motors for HEVs, PHEVs and EVs will require significant additional amounts of raw materials that are far less plentiful and recyclable than the principal metals used in conventional cars.
While lithium supplies are adequate, competing demands for rare earth metals and copper will be challenging. Global lithium supplies are adequate for the foreseeable future, but rare earth metal production is dominated by Chinese producers and prices have skyrocketed. As new mines become productive and recycling technologies are developed, the constraints will become less burdensome, but costs will remain significant. The biggest metal constraint will likely be copper because a conventional car needs 24 kg of copper while an HEV needs 34 kg, a PHEV needs 54 kg and an EV needs 94 kg. As a result the value of the copper in an EV will probably exceed the total value of the steel and aluminum combined.
Stop-start systems offer some of the best value for money CO2 reduction potential. Bernstein and Ricardo expect that virtually every conventional internal combustion powertrain in the mature markets will feature either simple or advanced stop-start systems by 2020.
Almost all widely hyped improvements to powertrain are based on old concepts. The fundamental chemistry and physics of powertrains have not changed significantly over the past 100 years, but design and combustion efficiency gains have provided continuous advances in power density while noise, emission and fuel consumption levels have decreased. The next 15 years will be characterized by an evolution of existing technologies and the co-existence of various powertrain options, rather than the emergence of a disruptive dominant new technology such as electric or fuel cell vehicles. Over the next 15 to 20 years electrification is expected to become commonplace, but Bernstein and Ricardo expect that three out of four vehicles will still have an on-board internal combustion engine.
While I am a frequent and relentless critic of lithium-ion and electric vehicle investments because I believe the investing public has unrealistic expectations about the amount of time that will elapse between introduction and commercial success Bernstein and Ricardo didn't reach any conclusions that I'd disagree with. They expect battery development timelines to be lengthy and improvements to be limited to ±5% per year. They expect manufacturers of electric vehicles and components to lose money for several more years as they try to overcome immense TCO disadvantages and establish a toehold in the mass market. These conclusions are entirely consistent with the industry's experience with HEVs which took almost a decade to achieve a 3% market penetration in the US. The process will be evolutionary rather than revolutionary and investors who pay premium prices for the stock of companies that won't hit their stride for another decade will suffer.
In the energy storage sector, the first big beneficiaries of powertrain improvements will be Johnson Controls (JCI) and Exide Technologies (XIDE) who make starter batteries. Since stop-start technology puts tremendous strain on the battery from starting the engine several times during a commute and carrying accessory loads during engine off intervals, the auto industry is rapidly increasing the per vehicle amount they spend on batteries. Historically a new car used a simple flooded lead acid battery that cost the automakers about $60. Because of the heavier battery demands of stop-start, automakers are rapidly shifting to AGM batteries that cost about $120 and dual battery systems that cost $120 to $180. On a per vehicle basis, JCI expects cars equipped with stop-start systems to generate twice the revenue and three times the profit margin.
While current battery technology may be good enough for basic stop-start systems, it is clearly inadequate for the advanced stop-start systems automakers want to implement to minimize emissions and maximize fuel economy. Those advanced systems will need far more robust energy storage devices like the battery-supercapacitor combination that Maxwell Technologies (MXWL) has introduced on diesel powered cars from Peugeot and the revolutionary PbC battery from Axion Power International (AXPW.OB) which is in advanced stages of vehicle testing by BMW and other automakers.
I continue to believe lithium-ion cell manufacturers including A123 Systems (AONE), Valence Technologies (VLNC) and Altair Nanotechnologies (ALTI) will be poor investments over the next seven to ten years because these companies are under immense pressure to reduce costs in an industry where materials represent 60% of pack level costs and heavily automated manufacturing methods keep labor and overhead in the 22% range combined. While there are some potential economies of scale to be realized in battery management systems and perhaps a more efficient use of raw materials, the gains are expected to be slow and painful during a period when profit margins are compressed to help heavily electrified vehicles overcome crushing TCO handicaps.
While I'm cautiously negative about battery manufacturers, I don't see any possibility that niche manufacturers like Tesla Motors (TSLA) can possibly live up to outlandishly inflated expectations and maintain clearly unreasonable stock market valuations by manufacturing niche products that can only appeal to a minute fraction of the car buying public. It took three years before Tesla sold its 2,000th Roadster. While there are a respectable number of reservations for the Model S that will debut next year, there is no reason beyond unbridled optimism to believe demand for a $60,000 electric passenger car is a well-spring rather than a puddle. Even NPR, a bastion of conservative thinking, has taken to pessimistic reporting on the near-term potential of the electric vehicle sector now that unlimited government spending on ideology seems to be going the way of the dodo bird. There will be some demand and Tesla may survive as a going concern, but I can't imagine how it will retain a market capitalization that's an eye-watering 11.2 times book value and 16.4 times sales. The law of economic gravity simply cannot be denied and it will not be mocked.
Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.
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